VAT on bank charges and other financial costs

Why the charge has no VAT on it

Schedule 9, Group 5 of the Value Added Tax Act 1994 lifts a defined set of financial services out of the charge to VAT, including dealing with money, the granting of any credit, and the operation of accounts. HMRC puts it plainly in VAT Notice 701/49 at paragraph 2.10: many of the charges a bank, building society or similar body makes in connection with running a current, deposit or savings account are exempt.

So the account fee, the overdraft arrangement fee, the CHAPS charge and the unpaid-item fee all arrive without VAT. There is no input tax in them, and a posting that recovers VAT on one recovers something nobody charged. Two exceptions in that paragraph do appear on real statements: certain financial certificates issued for third parties, and the extra cost of overprinted cheque books. The list of exceptions is not exhaustive.

Exempt is not the same as outside the scope

An exempt cost is still consideration for something the bank supplied to you. A payment outside the scope is not consideration for a supply at all — drawings, a dividend, a movement between two of your own accounts. HMRC's VAT Notice 700/12 asks for purchases and expenses net of VAT in box 7, and tells you to strip out wages, loans, dividends and expenditure outside the scope because it is not consideration for a supply. Bank charges are not in that exclusion list; the matching sales box explicitly takes in exempt supplies.

Treat the charges as outside the scope and the VAT payable will not move a penny, which is why nobody catches it. What moves is box 7, downward, every quarter.

Coding it in Sage

On Sage's standard defaults an exempt purchase belongs on T2; something genuinely outside the scope belongs on T9. T2 carries the net into the return, T9 keeps it off entirely. Bank charges go to T2 — not T9, and not the zero-rate code.

Tax codes are configurable and often get altered, so confirm the descriptions in your own installation before acting on any published list. Each code and the pairs that get mixed up are set out on our Sage VAT codes reference.

Coding it in Xero

Xero draws the same line in words rather than numbers: its exempt purchase rate puts the net into the purchases box, its no-VAT rate keeps the transaction off the return as a T9 posting would. Rates get added and renamed freely, so check yours — see our Xero VAT codes reference.

The financial costs that do carry VAT

The exemption is narrower than its reputation. Paragraph 1.6 of the notice lists what sits outside it, and several items turn up in ordinary SME ledgers:

• Safe custody and safe deposit facilities — taxable. Paragraph 6.6 confirms the purely physical service of safekeeping is standard-rated, though a global custody package wrapping safekeeping in with dividend collection and settlement is exempt as a whole.
• Advisory and management work — investment and tax advice, management consultancy, bookkeeping and service company administration including payroll.
• Debt collection — standard rate. HMRC's VAT Finance manual at VATFIN3255 says it is specifically excluded from the finance exemption, and treats the engagement as a single composite supply with collection at its core, so any negotiation element follows suit.
• Credit management and credit checking — paragraph 4.10 draws the line at who grants the credit. Manage credit you have not advanced and the supply is taxable, capturing credit checking, valuing security, deciding for the lender, record keeping and chasing arrears. Lend and administer, and it is exempt.
• Card terminal and imprinter hire, and sales of that equipment — taxable under paragraph 4.8, unless the hire forms an ancillary part of an exempt card service.
• Equipment leasing — a taxable supply of services, named in the paragraph 1.6 exclusions.

Interest, repayments and finance charges

Interest is the consideration for granting credit, and granting credit is exempt — paragraph 4.1. Repaying capital is not a supply in either direction; it is money going back where it came from. Neither produces input tax.

Care is needed where a document bundles exempt finance with something taxable. A lender's charge for arranging and running the facility follows the credit; a service sold alongside it, such as asset valuation or a credit report, does not. And a penalty for paying late is not consideration for anything — paragraph 4.4 puts it outside the scope, which is why a supplier's fee for a returned direct debit is outside the scope while the bank's own unpaid-item fee on the same statement is exempt.

Hire purchase against a lease: a worked example

Take a £24,000 machine, plus £3,000 of finance cost, over three years.

On hire purchase, the goods are supplied when the agreement starts. The financier charges VAT of £4,800 on the £24,000 cash price, and paragraph 4.2 makes the £3,000 credit charge exempt provided it is charged separately and disclosed to you. You recover the £4,800 on the return covering that date, subject to the usual rules, and later instalments carry no further VAT. The cash price is taken before any deposit or part exchange.

On an operating lease, nothing is supplied up front. You buy the use of the machine month by month, so VAT is charged on each rental and recovered as it falls due — roughly £750 a quarter rather than £4,800 at once. The first-quarter cash flow differs, and so does the fixed asset register.

Two traps. Personal Contract Purchase agreements where the optional final payment is pitched at or above expected market value are generally treated as leasing under paragraph 4.4, so every instalment is taxable in full even where the paperwork splits out a credit element. And an option to purchase fee is not part of the exempt credit: VATFIN3125 puts a fee buying the right to acquire ownership outside the credit exemption, while documentation and administration charges that are genuinely further consideration for the credit stay exempt unless the contract ties them to the goods. What the fee buys settles it, not the label.

A statement, line by line

The four things that actually go wrong

• Exempt costs coded as zero-rated. No effect on the cash, but the supply is misdescribed — and on the sales side the same confusion can lead a wholly exempt business to think it may register.
• Everything financial dumped outside the scope. The quiet one. Purchases understated quarter after quarter, nothing in the ledger looking odd.
• VAT reclaimed where none was charged. Usually a gross figure split 1/6 out of habit, or a default tax rate on a supplier record nobody set. This creates a real liability, with interest.
• Partial exemption built on bad data. With exempt income of your own, the de minimis test runs off the totals above. Wrong inputs, wrong recovery claim.

This is general information, not advice on a particular transaction. Where a charge is bundled with others the treatment follows the substance of what was supplied rather than the wording on the invoice, which is why two statements that look alike can need different postings. We prepare bookkeeping, VAT returns, management accounts, year-end accounts and Corporation Tax for owner-managed companies on Xero or Sage. We do not undertake audit or specialist tax advice; those are referred out.